Understanding how the incoming solar radiation is transformed into useful electricity can be a challenge by itself, but understanding the economics of solar can be even more daunting. After all, the premise of solar energy is entirely different from the conventional business model in the energy sector. Installing solar panels to your home is almost like buying a prepaid card of electricity and topping it up for 20 years of service.

levelized cost of solar energy lcoeOnce the initial installation bill is paid, there are very few expenses left to maintain your solar panels during their lifetime. There may be a need to change certain components (such as the inverter) over time, but solar panels are typically designed and manufactured to keep ticking year after year without any need for replacement. Thus, barring any major work on the roof that may necessitate removing and re-installing the panels, there should be no big bills left to pay once the system is in place.

Even though the initial cost of other household appliances such as a natural gas furnace may be well below the bill you will receive from your solar installer, there is one great difference: cost of fuel. With the exception of renewable energy sources such as solar, wind or geothermal, all conventional household energy appliances will cost you money month after month in the form of fuel bills. In contrast, the fuel cost of solar energy is zero and in the long-term, this simple fact translates into big savings.

What is levelized cost?

Levelized cost essentially means the cost of electricity at the point of connection to the grid, including both the initial costs and the ongoing expenses such as fuel and maintenance. Levelized cost is very useful when we need to compare the cost of different energy generation sources to the ratepayers.The term "levelized" refers to making an apples-to-apples comparison by including all relevant costs as well as the expected life time of the energy investment. Before solar energy became mainstream, the term levelized cost of electricity (LCOE) was mainly used to compare the cost of very large scale investments such as a new nuclear power plant or a new coal plant. However, the introduction of solar energy at the residential scale as a distributed energy generation source gave a brand new meaning to this concept.

How to calculate the levelized cost for solar energy

There are three main cost elements of any given energy source: the initial installation or construction costs, operating & maintenance  (O&M) costs and fuel costs. Solar energy happens to be "top-heavy" - the initial costs are quite high, but there is very little O&M costs and no fuel costs whatsoever. Thus, the first step is to estimate the life-cycle cost of a solar panel installation. Fortunately, this is quite straightforward, and all we have to do is to add the expected O&M costs on top of the initial installation cost. A relatively conservative estimate for the O&M costs would be about 20% of the initial installation cost. Thus, multiplying the initial cost by 1.2 would give a pretty close estimate to the life-cycle cost of your solar panels. For example, an average-sized residential solar panel installation with 5 kW capacity would cost about $14,000 ($20,000 minus the 30% federal tax credit) based on the estimates of the Solar Energy Industries Association. Adding a 20% margin for O&M costs gives us the life-cycle cost of $18,000.

The second step is to estimate the total amount of electricity your system will generate during its useful life time. When it comes to solar energy, it's all about location, location, location. Although the life-cycle cost will not change drastically based on your location, your expected electricity output will. This is where Sunmetrix Discover is particularly useful. Simply enter your location, and with a few clicks you'll be able to determine the annual average electrical output of your system. Since most solar energy installations have an expected life time of 20 years, we can multiply the annual average generation by 20 to get a quick estimate. For example, a 5kW system installed in San Diego (with a Solar Score of 79) would generate about 8,300 kWh of electricity per year (thus 166,000 kWh over 20 years). By comparison, the same system installed in Portland (where the Solar Score is 40) would yield about 5,500 kWh per year (or 110,000 kWh over 20 years).

The third, and final, step is to divide the life-cycle cost (Step 1) with the amount of electricity the system will generate in the next 20 years (Step 2). Thus, the levelized cost of solar energy would be $18,000 divided by 166,000 kWh for San Diego: about 11 cents/kWh. Whereas for Portland, we are looking at 16 cents/kWh. The same system, the same life-cycle cost, vastly different levelized cost numbers as a result of the location.

So how does solar energy compare?

The following table, compiled using data from the U.S. Energy Information Administration, compares the levelized cost of solar energy with other energy generation technologies. Solar energy is certainly not the cheapest alternative at the moment, but it is becoming more and more cost competitive as the industry matures. We should also mention that these are average figures, and depending on your location, solar energy may already be the cheapest option for your residential energy needs.

U.S. average levelized costs (cents/kWh in 2013 for plants entering service in 2020) source: EIA

Generation TypeLevelized Cost (cents / kWh)
Solar Panels10-20
Wind Turbines (excluding off-shore)7.4
Hydroelectric Power Stations8.4
Conventional Coal Fired Power Plants9.5
Nuclear Power Plants9.5
Conventional Combined Cycle Natural Gas Turbines7.5

Making sense of levelized cost figures

We should note that the levelized cost figures exclude the environmental impacts of competing energy sources, such as the cost of greenhouse gas emissions. When these costs are also factored in, the levelized cost of solar energy will become even more competitive. We should also note that, the calculations above are simplified as we didn't take into account the time value of money (we assumed that all the O&M costs are incurred at the beginning) and different financing options that may distribute the cost of the initial installation more evenly over time. You can use the built-in levelized cost calculator in Sunmetrix Discover for more detailed calculations.

Levelized cost of solar energy is closely linked to another core concept in solar energy: grid parity. Stay tuned for a more detailed post on grid parity and the evolving role of solar energy in our electricity mix.

Image credits:  Salvatore Vuono / freedigitalphotos.net